The clause pays the gap to a comparable customer's price, and most of the arithmetic is in making the comparison comparable.
A most-favoured-customer clause pays the difference between your price and the supplier's lower price to a comparable customer, but only after that lower price is restated on your terms: same delivery basis, same payment terms, comparable volume. On an illustrative supply contract at 52.00 a unit, a rival buyer's 49.40 ex works on 60 days is worth 50.18 on your terms, so the clause pays 1.82 a unit, 327,600 over the 18 months remaining, not the 468,000 the headline gap suggests.
Worked in full in Contract Management by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The clause appears in supply, licensing and services contracts wherever a buyer commits volume and wants assurance that a later customer will not get a better deal for the same thing. Its value depends on two pieces of arithmetic that are often skipped: the like-for-like adjustment, which decides how much is owed per unit, and the retroactivity wording, which decides how much of it the buyer actually collects.
| Input | Your contract | The other customer |
|---|---|---|
| Unit price | 52.00 | 49.40 |
| Delivery basis | Delivered | Ex works |
| Payment terms, days | 30 | 60 |
| Monthly volume, units | 10,000 | 12,000 |
| Lower price applies from | Month 7 | |
| Supplier's cost to deliver a unit | 1.10 | |
| Supplier's cost of money | 8% |
The clause is assumed to cover customers buying at least the same volume, which the other customer does at 120 per cent of yours, and to apply the lower price from the date the supplier granted it.
Add what the supplier saves by not delivering: 49.40 + 1.10 = 50.50.
Deduct the financing the supplier gives away on the longer terms: 49.40 × 8% × (60 − 30) / 365 = 0.32.
Comparable price = 50.50 − 0.32 = 50.18.
52.00 − 50.18 = 1.82, a 3.5 per cent reduction, against a headline gap of 2.60 or 5.0 per cent.
Months 7 to 24 are 18 months at 10,000 units: 180,000 units × 1.82 = 327,600, or 18,200 a month.
Excel, with the other price in B1, delivery cost in B2, cost of money in B3, the two payment terms in B4 and B5 and your price in B6: =B6-(B1+B2-B1*B3*(B5-B4)/365)
The clause is worth 327,600, 2.62 per cent of the 12,480,000 contract spend. A buyer who claims on headline prices asks for 468,000 and will lose the 140,400 difference in the first exchange of letters, because the supplier can show that the other customer collects its own goods and pays a month later. Worse, an inflated claim makes the legitimate part look like an opening position. Build the like-for-like price first and claim that.
The adjustments go both ways. Here the delivery saving of 1.10 narrows the gap and the longer payment terms, worth 0.32, widen it. Other common items are rebates and free goods, which lower the other customer's effective price; warranty and service levels, which may differ; and specification, which may make the products not comparable at all.
The volume test is a cliff. If the clause covers only customers buying at least your volume and the other customer took 9,000 units a month instead of 12,000, the payout would be zero, not a smaller number. Check the comparability wording before running any arithmetic.
Suppliers rarely announce that the clause has triggered. Whether a late discovery still collects the full amount depends on whether the clause is retroactive to the date of the lower price, or applies only from notification.
| Buyer discovers in | Retroactive clause | Prospective only | Lost without retroactivity |
|---|---|---|---|
| Month 7 | 327,600 | 327,600 | 0 |
| Month 10 | 327,600 | 273,000 | 54,600 |
| Month 13, at an annual audit | 327,600 | 218,400 | 109,200 |
| Month 19 | 327,600 | 109,200 | 218,400 |
| After expiry | 327,600 | 0 | 327,600 |
Without retroactive wording, every month of delay costs 18,200, and an annual audit right detects the lower price on average six months late. A retroactive clause also needs an audit right and a survival period after expiry, or the right column applies in practice anyway: a clause the buyer cannot verify is worth what the supplier volunteers.
Price the clause in three moves: restate the other customer's price on your delivery, payment and volume terms; multiply the gap by the volume since the lower price was granted; and check that retroactivity and audit rights let you collect it. Here that turns a 2.60 headline gap into 1.82 and 327,600, of which 109,200 depends on the word "retroactive". How each clause in a supply contract is priced against its alternative is worked through in the free workbook for this case; the companion question of comparing bids on total cost is in how to compare two supplier bids on total cost.
Restate the other customer's price on your terms. Add the cost the supplier avoids if the other customer collects its own goods, deduct the financing value of any longer payment terms, and allow for rebates. In the illustrative case, 49.40 ex works on 60 days becomes 49.40 + 1.10 - 0.32 = 50.18 on delivered 30-day terms, against a contract price of 52.00.
Only if it says so. A retroactive clause applies the lower price from the date the supplier granted it; a prospective one only from notification. In the illustrative case the lower price starts in month 7 and is worth 18,200 a month, so a buyer who discovers it at a month 13 audit collects 327,600 under a retroactive clause and 218,400 under a prospective one.
Customers buying smaller volumes, different specifications, one-off clearance sales and prices set under earlier contracts are commonly excluded. A volume test works as a cliff: in the illustrative case the other customer buys 12,000 units a month against the buyer's 10,000, so the clause applies; at 9,000 it would pay nothing at all.
This article is one calculation from Contract Management. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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